TEXT-S&P affirms Friends Life Group PLC

Fri Jun 29, 2012 11:07am EDT

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Overview
     -- Following further discussions with financial services restructuring 
company Resolution Ltd. and the management team at Friends Life Group, we have 
reviewed our assessment of the likelihood of the different exit options from 
Resolution's U.K. life insurance project, which created Friends Life Group PLC.
     -- Our base-case assumption remains that the Friends Life Group will 
continue to focus on both new and in-force insurance activities over the 
rating horizon due to our assessment of the financial and commercial 
advantages from this combination.
     -- We are therefore affirming our ratings on Friends Life Group PLC and 
its rated operating subsidiaries, which we continue to consider core to the 
Friends Life Group. At the same time, we are removing the ratings from 
CreditWatch.
     -- The negative outlook predominantly reflects the downside risks to the 
credit profile of the group from the potential exit options under 
consideration by Resolution Ltd., its ultimate parent.
 
Rating Action
On June 29, 2012, Standard & Poor's Ratings Services affirmed its 'BBB' 
long-term counterparty credit rating on Friends Life Group PLC. At the same 
time, we affirmed our 'A-' long-term counterparty credit and insurer financial 
strength ratings on its rated operating subsidiaries, Friends Life Ltd. (FLL; 
formerly Friends Provident Life and Pensions Ltd.) and Friends Life Company 
Ltd. (FLC; formerly Axa Sun Life PLC).

In addition, all ratings were removed from CreditWatch, where they were placed 
with negative implications on April 2, 2012. The outlooks on all entities are 
negative.

Rationale

The rating actions reflect the continuation of our base-case assumption that 
the Friends Life Group will focus on both new and in-force insurance 
activities over the rating horizon. Resolution Ltd. announced in March 2012 
that the most likely route for exiting its U.K. life insurance project, 
assuming no third party is involved, would be to create and separately list 
two legal entities: a closed fund consolidator (HeritageCo), and an insurer 
that would seek new business (OpenCo). We have had further discussions with 
Resolution regarding the strategic rationale and timescales for its six exit 
options: a cash sale, together or in parts, direct listing as a stand-alone 
entity, merger with another life company together or in parts, or separate 
listings of HeritageCo and OpenCo.

Of these, three involve some degree of separation. Nevertheless, in our view, 
there are disadvantages in separating its existing and new business 
activities. We also anticipate that the synergies created by combining these 
operations will grow over time as the profitability of writing new business 
improves. While we recognize that shareholders gain options through the 
creation of HeritageCo and OpenCo, we think that the degree of linkage between 
these entities could make a separation less attractive. We also consider that 
a formal separation depends in part on external factors such as the regulatory 
and financial market environment that may make such a separation less likely. 
Our base-case assumption, therefore, is that it is more likely that the 
group's current identity will remain intact. 

The rating actions also reflect our view that FLL and FLC will remain "core" 
to the overall Friends Life Group according to our group methodology. 
Currently, there are clear and integral linkages between these rated entities 
and the wider group. In particular, FLL is the main operating entity in the 
group structure and guarantees the debt issued by Friends Life Group PLC. We 
understand that the existing business within FLL and FLC will ultimately form 
part of HeritageCo.

While we recognize that realigning the legal entities offers some benefits 
from an operational, accountability, and transparency perspective, we consider 
that it also heightens the potential downside risks associated with some of 
the exit options available to Resolution Ltd. 

Exit options that involve the separation of new and existing insurance 
activities will be easier to execute following the split of business into 
HeritageCo and OpenCo. Downside risk to the ratings stems from the potential 
loss or relative reduction in the levels of expected synergies between 
existing and new business on the credit profile of the group. This risk has 
become more of a rating consideration because Resolution seeks an exit within 
our outlook horizon of two years. It will crystallize should Resolution choose 
any exit option that separates HeritageCo and OpenCo such that they do not 
form part of the same group. It would also arise if an internal review of 
future new business viability is triggered by the group's failure to deliver 
on its new business profitability targets. We consider this less likely to 
occur now, because the group has made progress on its targets in the year to 
date. 

Finally, downside risk would also crystallize if the profile of the group 
changed significantly, making it more of a closed fund consolidator. Thiswould
reduce the effect of synergies between HeritageCo and OpenCo. In 
addition, we view the business risk profile of a closed fund consolidator as 
being higher risk because of the volatile and uncertain nature of the 
transactions needed to sustain future cash flows. This would impair our 
assessment of Friends Life Group's business risk profile.

The ratings on U.K.-based FLL and operating subsidiary FLC reflect our view of 
the group's strong capitalization and strong investment profile. These 
positive factors are offset by the group's operating performance. Although it 
is improving, operating performance remains a relative rating weakness.

Outlook
The negative outlook primarily reflects the downside risks to the credit 
profile of the group from the potential exit options Resolution is 
considering. While we continue to assume that it is more likely that the 
group's current identity will remain intact, the negative outlook captures the 
downside risks of exit options that involve separation of existing and new 
business activities.

We may lower the ratings if it becomes evident that:
     -- The combination of new and existing insurance activities within the 
Friends Life Group is less likely than we currently assume; 
     -- Improvements in new business profitability from the U.K. business will 
not reach the target levels (in particular, GBP110 million value of new business
per year) and improvements in overall operating performance are not continuing 
(see "Friends Provident Life and Pensions Ltd.," Oct. 28, 2011); 
     -- The profile of the group is becoming more heavily weighted toward that 
of a closed life fund consolidator, causing the scale of value of new business 
(SVNB; defined as value of new business divided by value-in-force) to fall; or 
     -- Capitalization is declining from its current strong levels.

We may revise the outlook to stable if:
     -- The risk that new and existing insurance activities will be separated 
becomes more remote in our view; and 
     -- The group continues to make progress on delivery of initiatives to 
improve new business profitability, in line with our expectations and the 
externally communicated targets set by Resolution.

Related Criteria And Research
All articles listed below are available on RatingsDirect on the Global Credit 
Portal.
     -- Holding Company Analysis, June 11, 2009
     -- Group Methodology, April 22, 2009
     -- Interactive Ratings Methodology, April 22, 2009
     -- Use Of CreditWatch And Outlooks, Sept. 14, 2009
     -- Counterparty Credit Ratings And The Credit Framework, April 14, 2004


Ratings List
Ratings Affirmed; CreditWatch/Outlook Action
                                        To                 From
Friends Life Group PLC
 Counterparty Credit Rating             BBB/Negative/--    BBB/Watch Neg/--
 Subordinated*                          BBB+               BBB+/Watch Neg
 Junior Subordinated*                    BBB                BBB/Watch Neg

Friends Life Company Ltd.
Friends Life Ltd.
 Counterparty Credit Rating             A-/Negative/--     A-/Watch Neg/--
 Financial Strength Rating              A-/Negative/--     A-/Watch Neg/--

*Guaranteed by Friends Life Ltd.
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